Futures Trading Costs and Market Microstructure Invariance: Identifying Bet Activity

Abstract

Market microstructure invariance (MMI) stipulates that trading costs of financial assets are driven by the volume and volatility of bets, that are, transactions intended to produce idiosyncratic gains based on investors’ beliefs. With futures transactions data, we estimate bet volume as the trading volume of brokerage firms that trade on behalf of their clients and bet volatility as the trade-related component of futures volatility. We find that the futures bid-ask spread lines up with bet volume and bet volatility as predicted by MMI, and that intermediation by high frequency traders does not interfere with the MMI relation.

Keywords: Market microstructure invariance, bet volume, bet volatility, transactions costs

JEL Classification: G12, G14, G15, L10